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The efficient resolution of capital account crises: how to avoid moral hazard

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  • Gregor Irwin
  • David Vines

Abstract

This paper presents a model of capital account crises and uses it to study resolution mechanisms for both liquidity and solvency crises. It shows that liquidity crises should be dealt with by a standstill combined with IMF lending into arrears, whereas solvency crises should be resolved by debt write-downs. Dealing with solvency crises by lending would require a subsidy and this creates moral hazard, such as incentives for excessive borrowing, for too little equity financing and for investment in projects that are inefficient. The analysis underlines the importance of accurately assessing whether a crisis is rooted in a liquidity or a solvency problem.

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File URL: http://www.bankofengland.co.uk/research/Documents/workingpapers/2004/WP233.pdf
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Paper provided by Bank of England in its series Bank of England working papers with number 233.

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Date of creation: Oct 2004
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Handle: RePEc:boe:boeewp:233

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  1. Stanley Fischer, 1999. "On the Need for an International Lender of Last Resort," Journal of Economic Perspectives, American Economic Association, vol. 13(4), pages 85-104, Fall.
  2. Saporta, Victoria & Andrew G Haldane & Gregor Irwin, 2003. "Bail-Out or Work-Out? Theoretical Considerations," Royal Economic Society Annual Conference 2003 181, Royal Economic Society.
  3. Ashley Taylor & Prasanna Gai, 2004. "International financial rescues and debtor-country moral hazard," Econometric Society 2004 Far Eastern Meetings 561, Econometric Society.
  4. Olivier Jeanne & Jeromin Zettelmeyer, 2001. "International bailouts, moral hazard and conditionality," Economic Policy, CEPR;CES;MSH, vol. 16(33), pages 407-432, October.
  5. Dimitrios Tsomocos, 2003. "Equilibrium analysis, banking, contagion and financial fragility," FMG Discussion Papers dp450, Financial Markets Group.
  6. Geanakoplos, J. D. & Tsomocos, D. P., 2002. "International finance in general equilibrium," Research in Economics, Elsevier, vol. 56(1), pages 85-142, June.
  7. Giovanni Dell'Ariccia & Jeromin Zettelmeyer & Isabel Schnabel, 2002. "Moral Hazard and International Crisis Lending: A Test," IMF Working Papers 02/181, International Monetary Fund.
  8. Bolton, Patrick & Scharfstein, David S, 1990. "A Theory of Predation Based on Agency Problems in Financial Contracting," American Economic Review, American Economic Association, vol. 80(1), pages 93-106, March.
  9. Andrew G Haldane & Jorg Scheibe, 2004. "IMF lending and creditor moral hazard," Bank of England working papers 216, Bank of England.
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Cited by:
  1. Philipp Maier, 2007. "Do We Need the IMF to Resolve a Crisis? Lessons from Past Episodes of Debt Restructuring," Working Papers 07-10, Bank of Canada.

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